Conifex Timber Inc. (OTCPK:CFXTF) Q3 2022 Earnings Conference Call November 8, 2022 5:00 PM ET
Company Participants
Ken Shields – Chairman, President & Chief Executive Officer
Winny Tang – Chief Financial Officer
Conference Call Participants
Hamir Patel – CIBC
Paul Quinn – RBC
Operator
Good afternoon, ladies and gentlemen and welcome to the Conifex Timber Inc. Q3 2022 Results Conference Call.
I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead.
Ken Shields
Well, thank you very much, Paul and good afternoon, everyone and welcome to our call covering our Q3 results for 2022. CFO, Winny Tang, is next to me here today and available to respond to questions that analysts and shareholders may have following some prepared remarks. Let’s quickly deal with the housekeeping item. We will be making forward-looking statements and references to non-IFRS measures and therefore, call your attention to the complete warning statement set out on Pages 1 and 2 of the MDA that we released earlier today.
In Q3, we are pleased to report net income of $0.02 per share and EBITDA of $4.2 million was achieved. Our results for the most recent quarter were aided by a $5.7 million reversal of excess duty deposits paid in prior period. And of course, the reversal resulted from subsequent imposition of lower deposit rates. On the other hand, our results were held back by losses incurred at our power plant which was idled in Q3, while repairs were made to manufacturer defects in our turbine. Our bottom line was also held back by shift reductions and the curtailments at our sawmill complex. At our sawmill, normal 2 shift operations resumed on October 24. If I look at our Q3 results, as I see it, the nonrecurring items, namely the duties offset by the other 2 factors, they had an approximate equal and offsetting effects. So our normal results would have indicated a slight profit based on the numbers that I’ve been looking at.
So turning to the outlook for Q4, of course, we expect benchmark SPF lumber prices to be weaker than they were in Q3. And I’ve observed that most public lumber companies are guiding analysts to expect a sequential decline in EBITDA and net income in the closing quarter of the current calendar year. In our case, if benchmark SPF prices remain at or near their recent levels, we expect our Q4 results will be very similar to our Q3 results. And this is because recent discussions with our insurance adjusters have been highly encouraging. And based on these discussions, we expect to record business interruption insurance proceeds in Q4 in an amount that is expected to more than offset any potential income losses that may be incurred at our sawmill complex. So against this backdrop, our full year EBITDA and net income should come in within 10% of the record levels we achieved in 2021.
As at September 30, our potential refundable duties on deposit amounted to USD 30.6 million which translates into CAD 1 per Conifex share based on the 40 million shares we had outstanding at quarter end. And while we appreciate that the likelihood and timing of a full or partial refund is highly uncertain, our network will improve greatly when the trade dispute is eventually settled and cash refunds show up in our base account. We are not aware of any other publicly-traded lumber producer with potential duty refunds representing over 60% of their present equity market capitalization.
I’d now like to talk about fiber in BC. And as many of you will have heard on our last call in July, the Chief Forester in British Columbia issued a Public Discussion Paper and, at the same time, requested feedback from us and other licensees regarding the merits and demerits associated with future harvest level he may establish for the Mackenzie timber supply area which is the part of the province where we source all our fiber requirements. To this end, we met with the Chief Forester in October and came away feeling confident that sawlog supply in our operating region can be sustained at more than double our present annual requirements. And all this is illustrated in Slide 9 in the deck we distributed an hour or so ago.
We also feel confident that when the Chief Forester’s final report is released, likely before the end of the year, we will transition to a green timber supply and no longer be mandated to source an important portion of our harvest from stands dominated by uneconomic pulpwood and bioenergy fiber components. We trust that Chief Forester’s final report will also include recommendations to ensure sawlog supply available to sustain lumber production for decades to come in the ultra-forestry dependent community at Mackenzie. A topic we tabled at the meeting was for the Ministry to incorporate employment and community sustainability considerations in decisions impacting fiber sourcing locations, sawlog quality and low cost affordability in the Mackenzie timber supply area. We were pleased to have had an opportunity to present our views to Ministry officials which, if accepted and implemented, will help restore trust and confident in the Ministry’s oversight at the forest sector in Mackenzie.
I know many of you on this call analyze future supply-demand balances and lumber when you’re compiling your forecasts for future SPF lumber pricing. I’ve seen many thoughtful analysis about how timber supply will contract as the annual harvest in BC decreases due to beetle damage, government policy decisions such as restricting the harvest and also stands [ph], emerging species-at-risk protection initiatives, First Nations reconciliation activity and wildfires. However, the important role BC timber sales plays, supplying fiber to the BC forest sector is infrequently mentioned. Many of you would be aware that BC timber sales is responsible for managing the harvesting of approximately 20% of the timber available from British Columbia’s timberlands.
In the MD&A we released exactly 4 quarters ago, we disclosed that there was an 80% shortfall in BC timber sales auction volume in the Prince George and Mackenzie TSAs. Since then, there have been no new auctions in the Prince George timber supply area which, as many of you know, is the largest timber supply area in the province, nor have there been any auctions at all in the 2 timber supply areas to the North and East of Mackenzie. The Ministry blacked [ph] out performance accountability at BC timber sales. In our opinion, it’s the single biggest reason that sawlog harvest in the Northern Ontario region of BC declined 20% in the first 9 months of 2022 and why numerous shift curtailments and other shift reductions were announced at several Ontario BC sawmills and pulpmills.
As we see it, BC TS auction performance is showing little, if any, sign of improvement. We, therefore, believe that sawlog supply in BC may be even more restricted than most knowledgeable industry observers have been incorporating in their supply-demand models for lumber. And against this backdrop, we suspect that fiber constraints may be underestimated and that consensus SPF price forecast for 2023 may prove to be conservative.
So having reviewed these key industry developments, I wish to take a few minutes now to explain 4 initiatives that we are actively pursuing to position Conifex for success in 2023. First of all, we built up log inventories to ensure that we are not forced to curtail operations due to sawlog supply shortages. You may note that we had $25 million invested in sawlog inventories at the end of Q3 and this represents what we would view as an industry-leading 3-month’s sawlog supply. We plan to maintain inventories at this robust level at least through to the March 2023 spring breakup period. This log inventory buildup is, first of all, a testament to the mutually beneficial relationships we’ve established with local First Nations partners but it’s also an indication of how collaboratively and effectively local forest ministry officials and the Conifex fiber procurement team worked together to ensure that harvest permits are approved on a timely basis and that both employment and local government tax receipts [indiscernible].
The second initiative we have underway is that we are well advanced transitioning to the green sawlog stands and accordingly have spent considerable sums developing roads, bridges, camps and other support infrastructure, so we can access green stands in the new operating areas. The third initiative, we’ve completed some key improvements to our sawline and finishing lines at our sawmill complex, both designed to improve uptime performance and lumber recovery. And against this background, we expect our cash cost of producing lumber will be lower in 2023 than in 2022. Fourth and finally, we’re lining up customers for the richer grade outturns we expect to have available from processing the green log diet. We’ve got people in Japan today actually that are hard at work rebuilding our Japanese customer base to allow us to boost shipments of duty-free premium price J-grade lumber in 2022 and beyond.
In summary, successful execution of our transition to a green log diet reduces sawmill conversion costs, improves lumber recovery, provides richer grade outturns and boosts average lumber selling price realizations. These benefits will enable us to migrate to a lower and more enviable ranking on the lumber industry cost curve, thereby positioning us sustain capacity operations over an even wider range of commodity lumber prices.
I would now like to update you on another step in our journey in furtherance of our objective to develop the most economically-viable and environmentally-sustainable integrated softwood processing operations in the Ontario region of BC. As described on Page 3 of the MD&A we just released, we’re examining the feasibility of developing data center hosting activities in Northern BC that would consume the surplus power that BC Hydro expects to have available through the year 2030 and beyond. In furtherance of this objective, we are pleased to announce that we will be hosting a new customer at our trial site in Mackenzie. The customer is Greenidge Generation Holdings which is a NASDAQ-listed public company and it plans to locate its servers at our site in Mackenzie later this month. It’s a company that presently operates over 25,000 servers at sites in New York State and South Carolina.
Turning to our balance sheet. You’ll see that our overall debt was $57.8 million at the end of Q3, mainly represented by our power loan. And no amounts were drawn against our revolving credit facility. And when we deduct cash balances, we ended Q3 with net debt of approximately $29 million and a net debt to cap ratio of approximately 17%. Our solid financial position, $36 million in liquidity and powered by cash flow, give us confidence in our ability to endure a lengthy period of weak lumber prices, should this happen to occur.
Turning to capital allocation. At our August Board meeting, our Board of Directors approved reinstatement of the normal course issuer bid, entitling us to repurchase and cancel approximately 10% of our public float which works out to 2.46 million shares. We purchased 194,000 shares in September prior to entering a blackout period and we’ll be back in the market in a few days once the blackout period has lapsed. We note that our shares presently trade at an approximate 55% discount to our book value per share which is at much steeper discount than presently-recorded certain other public lumber companies. The reinstatement of our normal course issuer bid is underpinned by our belief that the trading price of our shares continues to reflect zero value for our harvest tenures at our sawmill.
Summing up our notes, we believe that Conifex is well positioned with its strong safety culture, an unparalleled degree of fiber self-sufficiency, near-term opportunities to improve product mix and revenue, industry-leading power generation assets, a strong balance sheet and exciting future potential hosting customers wishing to access BC Hydro’s abundant, affordable, surplus power [ph].
We thank you for taking the time today to learn more about Conifex. Winny and I would be very pleased to respond to any questions you may have.
And so I’ll now turn the meeting back to Paul, our operator.
Question-and-Answer Session
Operator
[Operator Instructions] The first question is from Hamir Patel.
Hamir Patel
Ken, given some of the issues with the BC timber sales that you were highlighting, just how much capacity do you think might come out of BC next year, just given the pine beetle and old growth plans of the government?
Ken Shields
Well, Hamir, we have our hands full keeping track with what’s going on in the Mackenzie timber supply area which I think many of you are aware, over the land mass that’s as big [indiscernible] Vermont and New Hampshire combined. But I can tell you that the Prince George timber supply area is located just to the South of that, it’s the largest timber supply area in the province. And the latest information that I have on the TSA is that licensees, early in Q3, began working on the basis that their harvest was being reduced by something like 19%. In October of this year, last month, the harvest level in the TSA was further reduced by 14%. And then as I mentioned earlier, in that TSA, we’re not aware of — there’s always a chance I missed the odd sale but we’re not aware that there’s been any BC TS timber sale. So Hamir, there is an example of a 33%, a 14% [ph] and as much as another 20% reduction. So it’s a very significant downtick. In the first 9 months of this year, I think the Ontario BC harvest was down 19.7% or something like that, almost 20%. And I don’t expect that year-over-year rate of decrease to abate any time soon.
Hamir Patel
Yes, fair enough. That’s helpful. And just a final question I had for Winny. Could you speak to how we should think about CapEx in 2023?
Winny Tang
So we’re still in the process of finalizing our 2023 capital and business plan. You will see, though, we will likely be guided by our amortization charge and we expect it should be in line with our annual amortization charge.
Operator
[Operator Instructions] The next question is from Paul Quinn, RBC.
Paul Quinn
Just curious on what happened up in Mackenzie with stumpage October 1, what you expect January 1 and the balance of ’23 [ph]?
Ken Shields
The stumpage in Mackenzie, Paul, is — it’s very complicated and it’s something that if you wish to discuss offline, I’m very willing to do so. But I wanted to point out that we have 2 distinct logging seasons in Mackenzie. In the winter logging season, we harvest — that is close to our sawmill complex. All the wood is delivered by truck. And so it’s a low-cost region and that triggers pretty high stumpage. In the summer months — in the summer logging season, when the Williston Reservoir [indiscernible] free, we operate from a way more remote location and the higher cost locations — we run camps, we’ve got long delivery distances to get the wood from the north end of the reservoir down to our site so that in a year when stumpage did not change, let’s assume that the BC government’s stumpage rate was constant throughout the year, we’d have much higher stumpage on the winter logging season than on the summer logging season.
So what happened to us this year is that, as we got into Q3, our stumpage build didn’t change very much but we incurred a lot more cash cost in harvesting and delivery. And so when we get into the logging season, we think that there won’t be much change because stumpage rates are coming down but we’ve got fewer cost allowances which will trigger a higher stumpage rate. So that background, our stumpage rates have been pretty flat throughout the year but our log costs weren’t. They were a bit higher in the summer months and they were lower in the winter months. So as I said, it’s a complicated topic but that’s what happened to us in Mackenzie.
Paul Quinn
Okay. Then given that overall BC stumpage is expected to go down in ’23, do you expect the lumber prices to track down with it?
Ken Shields
Well, Paul, I really don’t, because, as I said earlier, if there was a precipitous decline in residential construction activity, both for new [indiscernible] in the U.S., I suppose they could go back. Let me ask you this question. Some of the companies have reported walking write-down to net realizable value. One company reported $90 million, another couple reported $35 million and one other reported about CAD 25 million. So those inventory write-downs are very high relative to what the alternative is of setting sawmills down. So we think that some companies in BC would be pretty poised to take downtime if lumber prices slide from here because it’s so-so they want to continue utilizing the cash flow from the low-cost supply region to subsidize ongoing production in the high-cost region of BC. So we don’t see the stumpage rate reduction triggering heightened production from BC. We continue to believe that supply and fiber constraints in BC will not lead to an oversupplied market on a sustainable basis.
Paul Quinn
Okay. And then just flipping over to the power side. What’s the status of the generation right now? What do you expect for ’23?
Winny Tang
Yes. So we’re still actually in the process of working with the original manufacturer on repairs to — maintenance defects on the turbine. We are expecting the power plant to come back online in or around January 2023. And we look forward to that as that’s one of our peak times we’re generating revenue because of the time and delivery factor.
Paul Quinn
So at the end of the day, do you expect the ’23 revenues to be up over ’22 revenues, given the downtime that we experienced this year?
Winny Tang
Yes, I would say that we would see a revenue uptick in revenues as a result of the power plant contribution. We will — however, we are expecting to see some net earnings impact from business interruption claim on the power plant in 2022.
Paul Quinn
Okay. I didn’t mean to ask [indiscernible]. But — and then just maybe Ken, you mentioned the dollar share is in duties. How do we solve this at this point? What’s your current thinking?
Ken Shields
Well, I’d like to tell you that I had a 2.5 hour dinner last night with a lumber trade expert and that we identified a clear path forward but I can’t say that. It looks like there continues to be no incentives for the U.S. coalition to want to show up at the bargaining table. So that’s an unsettling element in the potential for a trade settlement. But on the other [indiscernible] duty rates came down this year, as you well know. And later this year, we expect another announcement about preliminary duty rates and there’s powerful evidence that the duties will further reduce. So when I think about the position of a U.S. lumber coalition member that has seen this massive part of duty deposits build up and if they want a share of that, that pot’s unlikely to be increasing very much, 12 months or so from now. So I think that there will be a financial incentive for the U.S. to show up at the bargaining table in the next 12 or 14 months.
Paul Quinn
Okay. And what’s your estimation of the size of the massive pot?
Ken Shields
The last number, Paul, either it was $9.4 billion [ph].
Paul Quinn
And that’s U.S., right?
Ken Shields
Yes.
Operator
There are no further questions registered at this time. I will return the call back to Mr. Shields.
Ken Shields
Okay. Well, thank you, Paul. Winny and I always enjoy our discussions with all of you on the line. Thank you for your interest in Conifex and we look forward to speaking to you again early in 2023 with another quarter of [indiscernible] income on our bottom line. So all the best. Thank you.
Operator
Thank you. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.
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